ARE WE RAISING THE STANDARDS FOR FINANCIAL REPORTING – OR TAKING A STEP BACK?

“Everyone’s doing it.”

“It’s immaterial.”

“It’s been approved.”

“I’m just following the rules.”

These are the kinds of rationalizations that were made by employees during the Enron accounting scandal of 2001, William Craig, Chief Executive and Financial Officer of Tarantin Industries, told audience members during an ethics panel discussion at the CFO Innovation Conference. “Everybody in the organization maybe felt that what they were doing wasn’t quite kosher, but they did it anyway because it was approved and part of the culture,” he said.

As proof, Craig cited a recent memo that prominent hedge-fund manager and investor Whitney Tilson fired off this spring to top financial executives after witnessing a speech delivered by former Enron CFO Andrew Fastow, who served a six-year prison sentence for multiple charges in the Enron case. By Fastow’s own admission, Tilson wrote, Enron knowingly engaged in repeated transactions that were designed to mislead investors by hiding debt and special-purpose entities. “It wasn’t one deal that sunk Enron,” Craig said. “It was the repeated use of acceptable but gray techniques that were used to pretty things up.”

In the 15 years following the scandal, has the financial world learned from Enron’s mistakes? Craig fears the answer is “no.” Again citing Tilson’s memo, he said that many companies, including Apple, “continue to engage in behaviors like tax-dodging that, while technically legal, are designed to increase profits and inflate the stock by confusing regulators and investors via a massively complex web of entities … which is exactly what happened at Enron,” he said.

In a recent survey of 400 financial executives by the National Bureau of Economic Research, 20 percent of respondents admitted to distorting their company’s earnings figures by an average of 10 percent. “That’s just scary bad,” Craig said. At the same time, he said, the Financial Accounting Standards Board recently released a proposal that might make it easier for public companies to withhold key financial information from shareholders. Current standards, he said, require corporations to provide financial disclosures of information that “could” influence investors. The FASB’s new proposal would rewrite this standard so that corporations would have to disclose information only “when there is a substantial likelihood that the information might significantly alter investor decisions,” according to Craig.

“Is the bar being raised here? No,” Craig said. “This is so much open to interpretation; I see us moving backwards.”

The issues surrounding financial reporting are not the only ethical questions that should be on financial chiefs’ radars, warned panelist Eric Wukitsch, Chief Operating and Financial Officer of Vantage Custom Classics, Inc. Companies also need stricter ethics codes in place. This applies even to private firms, who are not bound by the Sarbanes-Oxley Act, especially when they’re doing business overseas, said Wukitsch.

“What’s ethical may be illegal in some countries and what’s legal may be unethical,” he said. As an example, in the apparel industry, Wukitsch said, it’s common to pay workers in some countries with a bag of rice for a month’s worth of work. “It’s legal, but is it right?” he said. Companies need to outline specific guidelines for issues such as compensation and employee safety in their ethics codes and communicate them to all employees. Firms that fail to do this may face criticism from customers, vendors, and financial institutions.

“With all of the focus on social responsibility right now, you need to show that you’re doing the right thing,” he said.

Gary Piscatelli, Senior Vice President and CFO of Hunter Douglas North America, tackles his job using a holistic approach, which is exactly how the company, the worldwide market leader in window coverings, established its prominence. The Netherlands-based company —with its North American headquarters in Pearl River, NY— stands out from competitors with its commitment to creating innovative product designs that fuse form with function to meet the evolving needs of the marketplace.

Piscatelli oversees the organization’s finance, technology, and human resources groups. Among other projects, he is helping Hunter Douglas to improve its data-gathering, reporting, and analytical systems in a way that enhances the company’s business operations. That means establishing more standardized information and systems without detracting from the magic that has driven so much success.

Looking at Information Anew

“Historically, operations were run in a somewhat decentralized manner,” he says, “but we are now moving toward greater centralization when it makes sense. We need a common language to ensure that metrics and measurements align, so when we talk across departments and functions, everyone is using the same definitions.”

Piscatelli joined the company a year and a half ago, following stints with Gillette Co., Nestle, and Timex Group, where he was involved in a comprehensive array of operations. Today, Piscatelli draws deeply on his previous experiences.

“The CFO is seen as a custodian of the company’s assets,” he says. “That reaches across many functions, and combined with the responsibility for business operations, means you’re basically connected to almost every part of the company. So you look for commonalities, ways that you can standardize and simplify functions and operations, not for the sake of standardization, but to help accelerate a company’s ability to achieve.”

Recently, Hunter Douglas converted the fabrication segment of its business from one that relied on a combination of independent and company-owned services, to one that is now entirely owned and operated by the company, bringing complete control of the manufacturing, assembling, and wholesale distribution aspects of the business under one umbrella. The increased vertical integration has helped to drive a change in the way the company looks at its data.

“When you’re tying together so many operations, it changes the way you gather and utilize your data,” says Piscatelli. “Ensuring that your data is accurate, and that you’re able to get at it, becomes a high-priority imperative. And it’s not a simple one. Among other challenges, it means gaining consensus on common standards, common hierarchy of information, and common goals.”

He sees the strategy to build a robust data architecture as both a logical and emotional journey. Building a comprehensive interconnected data set that links all the dimensions of a business at a level that drives understanding and decision-making without being overly complex is not simple. Getting it done with companywide consensus can be even more challenging. As challenging a task as this may be, capturing the right data is a critical enabler of strong business partnering.

Piscatelli sees partnering as an essential role of finance, but the function needs to first ensure it’s got the basics covered. To begin with, he says, “a company needs a solid foundation made up of accurate accounting and a strong system of internal controls. Once those are in place, a CFO and his or her team can drive financial improvement through cost containment, top-line growth, and delivering more bottom-line value.”

Sharing Data Drives Efficiency

“If you want to create value, you have to ensure that everyone has access to the information they need to do their job right,” he says. “Regardless of whether you’re talking about production—which involves keeping tabs on everything from inventory to manufacturing—or product, or branding activities, or cost centers, or customer information, you need to be able to get real-time information so you know where the company is right now, and use that as a planning guide to determine where you want to aim in the future.”

Piscatelli is well qualified to address and integrate these myriad concepts — his background includes responsibility for purchasing, financing, information technology, and other functions. He also understands the human angle.

At Gillette, prior to leading finance for the Personal Care Business, he served as Director of Corporate Finance, where he led a global SAP implementation that included revamping data architecture, accounting, reporting, and analytics. Afterward, he was Senior Vice President and CFO at Timex Group, where, among other things, he drove changes in reporting and analytics that he believed helped enable the transformation of the financial function from accountants to involved business partners.

A lot of the information may be on a sales invoice, but it’s useless unless a data system can capture it and present it in a meaningful manner. “The key is to structure a system that can capture data from disparate sources and integrate it all in a way that makes sense,” says Piscatelli.

As part of the effort, Piscatelli is talking to employees at all levels and functions across the company, and will continue to, asking key questions that will better enable systems that will aid Hunter Douglas to deliver more value. That’s where the human element comes into view.

“People are more likely to be candid with you if they know their statements are being taken seriously,” he says. “We let our co-workers know that they are an integral part of the Hunter Douglas operations, and that their input and activity will be vital to the company’s success.”

In addition to updating its internal data-gathering and reporting models, the company has recently had a changing of the guard in the C-suite. At the beginning of July, longtime Hunter Douglas North America CEO, Marvin B. Hopkins, retired. Ron Kass was named as the new President and CEO. Kass joined the company in 2005, previously serving as President of both the Hunter Douglas Design Products Group and the Independent Fabricator Group of companies, and as Executive Vice President of Marketing, where he oversaw brand marketing, advertising, and communications for Hunter Douglas.

“Our underlying strategy has not changed,” says Piscatelli. “Hunter Douglas has a long legacy of bringing to market well-designed, high-quality, and otherwise superior custom window treatments that are both profitable for the company and sought after by consumers. We are well positioned to continue this trend moving forward to maintain our leadership position.”

Chief financial officers for tax-exempt organizations came together recently at Red Knot Restaurant in Kenilworth, NJ, to discuss operational and reputational risk in their organizations. The event was part of CFO Studio’s Executive Dinner Series. The discussion leader was Bob Barry, CFO of Community FoodBank of New Jersey, one of the largest food banks in the country, distributing 44.6 million pounds of food in the year ended June 30, 2015. Mr. Barry led off by saying that public perception can affect the level of donations that tax-exempt organizations depend upon for funding. Today’s charitable donors do their research, so information that is publicly available can help or hurt tax-exempt organizations. “From a reputational standpoint,” he asked the CFOs from other tax-exempt organizations attending the dinner, “how do you meet your donors’ expectations and/or your grantors’ expectations?”

IRS Form 990 and Reputational Risk

Mr. Barry noted that IRS Form 990 is a valuable reputational-risk mitigation tool. It allows tax-exempt organizations to provide would-be donors not only with information about their finances, but also with insights into their mission and programs. “That form is something that we control. That is our document. Nobody sees it until we review it, understand it, and know what the implications are,” he said. The IRS allows any number of pages of supplemental information. Mr. Barry said that the FoodBank’s 2014 Form 990 supplement ran to 127 pages.

GuideStar and Charity Navigator, whose missions are to help donors evaluate charities before giving, receive the 990s from the IRS and use information from them to rank charities. A key point, said Barry, “is the first page, line 19, net excess/net deficit. I can tell you from my experience that the deficit is harder to deal with than the excess, because donors really don’t want to see money going to waste.”

Net excess is a potential difficulty for William Curnan, Chief Operating Officer for Ewing, NJ–based Advancing Opportunities, which provides services to individuals with disabilities. He said that when he files the Form 990, he adds an MD&A (management discussion and analysis) letter to explain that the organization’s mission involves building residences so that people with disabilities can live where they choose. He needs to explain this because the housing that Advancing Opportunities builds under the government’s Olmstead grants program looks on paper to be an asset. However, “I’m never going to sell it. I’m never going to leverage it. It’s deed restricted. I can’t do anything with it, but on paper, it’s a [large] asset,” said Mr. Curnan.

Form 990 is not required of religious organizations. John Balzano, Chief Financial Officer for Sisters of Charity of Saint Elizabeth, NJ—which is engaged in educating the young, caring for the sick and the elderly, and helping the poor—does not file a 990. He stated that a CFO, simply by his or her own reputation and knowledge, takes a lead role in answering questions about finances, whether or not it is a tax-exempt entity. “ACFO brings a sense of confidence and accountability that those financials are right. Whether you’re showing huge profits, or huge losses, you just need to present financial data properly and explain the results in the MD&A letter.”

Peculiarities to Report on 990s

Timothy O’Donnell is Chief Financial Officer for the International Neurotoxin Association, composed of physicians from all over the world who meet every two years to share information and the results of their work in promoting different uses for neurotoxins (treating migraine headaches and cerebral palsy, as well as erasing wrinkles with Botox). O’Donnell’s dilemma is that biennial meeting schedule, which means revenues spike every other year. “Our 990 looks very unusual,” he said, because there are swings in both assets and activity from year to year “due to the nature of the organization’s meeting.”

Early in her tenure at Family & Children’s Service of Monmouth County, Anna DeJesus, Chief Financial Officer, said she found it necessary to pull back on expenses because the organization was losing money. “We wound up with a slight profit [and for] the next three years, that profit grew, but we also did a new strategic plan. A high priority on the strategic plan was to build a [six-month] reserve.” She added, “Our programs are significantly funded by government grants, which can be cut at any given time. The reserve was extremely important.”

Ms. DeJesus said that she posts the 990 on GuideStar every year. “We’ve shown three years of steady growth, and our development department has seen a substantial increase in the number of contributors. Donors feel very confident in what we’re doing.”

“Because they believe in the mission, obviously,” said Mr. Balzano.

“That’s correct, they believe in our mission,” said Ms. DeJesus. That mission includes providing Reading Buddies to foster literacy skills for children in underserved public schools, Adult Protective Services to intervene on behalf of abused, neglected, or exploited adults, and 11 additional human service programs that reach more than 7,000 at-risk individuals and families annually, without including the organization’s thrift shop clients. “But there is no mission without money… no margin, no mission. Even Mother Teresa understood that.”

GuideStar and Charity Navigator look at the ratio of money that goes to General and Administrative (G&A) expense versus money spent on programs. According to Mr. Barry, no more than 12 percent should go to G&A. Also, Charity Navigator “looks at your development costs as a function of how it relates to money raised,” he said.

Both Mr. Curnan of Advancing Opportunities and Ms. DeJesus rely heavily on funding from government grants, and because of the nature of some of those grants, the organizations’ total G&A percentage is higher than 12 percent. Mr. Barry said that reporting of G&A on the 990 is totally separate from reporting that goes to the grantor. “I didn’t really appreciate how much [the rating organizations] looked at the 990 until we had a meeting with Charity Navigator. [The 990] is really what keys their whole analysis, and that is what donors look at now too.”

Schools’ and Colleges’ Funding

Eileen Black, Controller with Stevens Institute of Technology, a private research university in Hoboken, NJ, files a 990 but does not include MD&A information. Instead, the university relies upon its development department, other leaders, alumni, and students “to generate excitement about the mission and what we’re accomplishing.” The university has received national and worldwide recognition in publications. Also, the research in which Stevens’ professors and students are engaged —and its contribution to technological innovation— is also an important part of the university’s mission and has contributed to the reputation that Stevens has established. “This recognition has been a significant factor in rising contributions,” Ms. Black said. “Other nonprofits should consider using media, social media, or other avenues to enhance the excitement about their mission, not just the Form 990.”

Mr. Balzano, who has worked in both the public and nonprofit sectors, responded with a comparison of for-profit financial planning to tax-exempt planning. “When you create a [corporate] plan, people spend so much time on the expense side of it. ‘What’s my travel budget?’ ‘What’s my utilities?’ ‘What’s my insurance?’ [But in the tax-exempt sector,] you’ve got to spend your time on the revenue side of the plan. The Sisters of Charity sponsor two Academies and a College, and in talking with them, I always stress the importance of the revenue side. I say, ‘What are you doing to raise revenue and what are your metrics?’ They have their donors and their fund-raising events, but [those sources are] generally not enough to achieve their mission. Unless you build into people’s minds how to get funding, how that works, they tend to focus more on, ‘How can we cut costs here?’ You can never save yourself rich. That’s just not possible.”

“That’s the Howard Johnson’s model,” said Andrew Zezas, publisher of CFO Studio magazine and host of the event. “The story I’ve read is that decades ago, the CEO of Howard Johnson’s — the company that invented and originally succeeded at the roadside hotel-and-restaurant chain concept —eventually focused little on top line. It was all ‘cut expenses, cut expenses,’ at the expense of everything, including quality and service. The shame of it all is, when was the last time you ate or stayed at a Howard Johnson’s?”

The Compensation Pitfall

The salary of the tax-exempt organization’s CEO must be reported on the Form 990, and becomes public knowledge quickly. The form was revised in 2008 to require such organizations to report on the process of determining compensation. “Whether the [compensation committee is] making an adjustment for a bonus or whatever, you have to document what the change is and why and what data was used,” said Mr. Barry.

“We had some lean years during which the CEO did without pay, and I applaud her for doing that,” said Martin Mussman, Treasurer, New Jersey Coalition for Inclusive Education, which helps create neighborhood schools where children with disabilities and learning differences are welcomed as classmates and empowered to succeed. “So we negotiated a 10-year payout to make up for that.” But as a result, the Form 990 does not tell the whole story about that CEO’s compensation.

Some attendees mentioned that their executives expressed alarm that their salaries are publicly available. The salary of the CEO is, most agreed, a matter of great donor interest. People go to that part of the 990 and ask, “‘Is it justified?’” said Mr. Balzano. He added, “You should never be embarrassed about what you make if you’re really making a contribution and fulfilling your mission. But I find it interesting how so many tax-exempt leaders feel very sensitive about that information.”

“I think there’s that perception that we should be doing this out of the goodness of our hearts,” said Suzanne Schwanda, Senior Vice President of Finance and Administration, Special Olympics New Jersey, which provides year-round sports training and athletic competition for children and adults with intellectual disabilities.

Other Types of Risk

Besides reputational risk, the group discussed operational risks, including the risk of recession and the risk of having to sell real estate at an inopportune time. On the latter point, Mr. Zezas said, “The time to sell real estate, especially in sale-leaseback transactions, which are more structured finance than real estate transactions, is not when the organization is experiencing financial challenges. It’s the same approach as deciding when to borrow from a bank. The best financing terms, whether at a bank or in a real estate transaction, can most often be achieved when your organization is performing well. That’s the time you get the best terms, because your risk profile is more advantageous to banks, lenders, investors, and others.”

Another aspect of operational risk is being too dependent on funding coming from one source, such as the government or a foundation. “We worked really hard back in 2008 to diversify our sources of funding,” said Ms. Schwanda. “We actually expanded the number of special events we do, and gave participants incentives to reach out to friends and families to help sponsor them to reach different levels. That greatly increased the revenue we received from these fund-raising events.”

After nearly two hours of conversation, it was clear that the group members were experts at what they did, which was to facilitate people doing good and delivering services to others. “One of the challenges that all of you folks have in common is that you’re very often working for organizations that are short on resources, short on business acumen at some levels, and long on good intentions,” said Mr. Zezas. “Where strong leadership is unavailable, an organization may miss important opportunities.”

Mr. Barry described a conversation that he’d had with the CFO of a major international corporation who told Barry, “‘Your job is much harder than mine.’ That felt good,” said Mr. Barry. At tax-exempt organizations “we’re in the trenches. We deal with substantial risk without big staffs and dependable revenues.”

“There’s no stockholder taking money, there’s no owner taking money, but every dollar you spend, every dollar you save goes back to the programs and the people you serve,” said Mr. Curnan. “That’s unique. … You control whether you’ll be successful or fail, and that’s a tremendous responsibility.”